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Types of mortgage explained

Types of mortgage explained

Different mortgage types can seem confusing, so here's a guide to the pros and cons of fixed-rate mortgages, tracker mortgages and discount mortgages.

When you have a mortgage application accepted and start paying it back each month, you will pay an initial interest rate for a set period of time, after which a new rate will kick in.

Repayment mortgages

With a repayment mortgage you gradually pay off all the money owed on your house, as well as the accrued interest in a single payment each month until all the capital (the sum owed on your house) has been repaid.

At the start of your mortgage term, when the debt is at its largest, the monthly payment will comprise more interest and less of the debt itself. As you get further into the term, you pay a larger proportion of the debt while the proportion of your payment made up of interest gets less.

You will pay off the whole debt with this type of mortgage by the end of your agreed mortgage term.

This is in contrast to interest only mortgages where you only pay off the interest on your debt each month – but you’ll still have the cost of the house capital to find at the end of the agreement.

Fixed-rate mortgages

This is where you pay the same rate of interest for the entire period of your fixed-term deal.

With a fixed-rate mortgage you know in advance exactly what you’ll be paying back each month for a set period of time, which can be up to 10 years. This is unlike a variable rate mortgage which can go up and down.

They offer a fixed rate of interest normally lower than the Standard Variable Rate (the lender's own basic interest rate) and are currently some of the cheapest ever offered.

You are tied in even if interest rates fall – and would possibly have to pay a fee to leave the agreement.

When the fixed period ends, you move onto the lender’s Standard Variable Rate (SVR - see below), or you can remortgage.

Your lender’s Standard Variable Rate is set by the lender itself and is usually higher than most mortgage deals available. These don't all track the Bank of England’s base lending rate
and can move up or down whenever your lender decides.

It’s what you are transferred to when a fixed-term deal ends, so it is worth shopping around if you find that you’re on the SVR mortgage rate.

Lenders can raise or lower their SVR at any time – even when the Bank of England rate remains unchanged.

Tracker mortgages

This is where your interest rate follows the Bank of England’s base lending rate.

When the tracker mortgage rate is low, you could take the opportunity to overpay each month.

Your repayments aren’t dictated by your lender’s own rate – just the Bank of England.

You won’t know for sure how your payments will change through the set period of the deal.

Unless it is a “lifetime tracker”, when the fixed period ends, you move onto the Standard Variable Rate, or can remortgage.

Discount mortgages

This is where you pay the lender’s Standard Variable Rate, with a fixed discount each month for an agreed period of time.

Discount mortgages can be capped (so they don’t go too high) or collared (where the rate can’t fall below a set figure).

Your rate will always be below the SVR for the term of the agreement, but the lender can change the SVR at any time.

There could be a leap in payments at the end of the fixed term when you are transferred to the SVR.

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